As of year-end 2009, the FDIC identified 702 banks as "problem institutions," representing about 9% of all institutions reporting to the FDIC and the highest number of problem banks since 1993, according to the FDIC’s latest banking report.

 

On February 23, 2010, the FDIC released its Quarterly Banking Profile for the fourth quarter 2009, which can be found here. The FDIC’s February 23, 2010 press release describing the report can be found here.

 

The FDIC defines "problem institutions" as those with "financial, operational or managerial weaknesses that threaten their continued financial viability." Problem institutions are ranked as either 4 or 5 on the FDIC’s 1 to 5 scale of "risk and supervisory concerns." The FDIC does not publicly identify the problem institutions by name.

 

The 702 problem institutions at year end (out of 8,012 reporting institutions) represent the largest number of problem institutions since 1993. The 702 institutions also represented combined assets of $402.8 billion. The year end number of problem institutions is 27 percent greater than the 552 problem institutions as of the end of 3Q09. The 2009 year end figures compare to the 252 problem institutions, representing $159 billion in assets as of the end of 2008.

 

Given that the "problem institution" category tracks banks with "financial viability" concerns, it is hardly surprising that the increase in the number of problem institutions has been accompanied by a growing number of failed financial institutions. There were 140 bank failures in 2009, and there have already been 20 bank failures already in just the first seven weeks of 2010. The number of bank failures so far this year suggests that we may have at least as many if not slightly more bank failures this year compared to last year.

 

The FDIC’s report comes on the heels of the recent report of the Congressional Oversight Panel (about which refer here), in which the watchdog committee warned that coming commercial mortgage woes could further damage many lending institutions.

 

But not all of the banking news is bad. FDIC Chairman Sheila Bair is quoted in the FDIC’s press release as saying that the FDIC sees "signs of improving performance in the industry, " although basically that means that the pace of deterioration has slowed, not necessarily that the negative trends have been reversed.

 

Whatever else that might be said, the continued increase in the number of problem institutions as 2009 progressed suggests that we can expect to continue to see growing numbers of failed financial institutions as 2010 unfolds.

 

A Business Week article about the FDIC’s report can be found here, and a New York Times report can be found here.

 

In an interesting and potentially significant February 22, 2010 opinion (here), Southern District of New York Judge Naomi Reice Buchwald denied defendants’ motions to dismiss the plaintiffs’ ’34 Act claims in the Ambac Financial subprime-related securities suit. Judge Buchwald also denied the motion to dismiss the plaintiffs’ ’33 Act claims relating to the company’s February 2007 securities offering, but granted the defendants’ motion to dismiss the plaintiffs’ ’33 Act claims relating to the company’s March 2008 securities offering.

 

Judge Buchwald’s decision is particularly noteworthy for her rejection of defendants’ attempts to argue that the company’s woes were not the result of fraud but rather were the result of the global financial meltdown; among other things, she stated that "the conduct that plaintiffs’ allege, if true, would make Ambac an active participant in the collapse of their own business, and of the financial markets in general, rather than merely a passive victim."

 

Background

Ambac Financial Group is a monoline insurer providing protection against credit risk. Traditionally the company insured municipal bonds, but in more recent years prior to the financial crisis, the company increasing provided default protection for structured financial products such as residential mortgage backed securities (RMBS) and collateralized debt obligations (CDO).

 

In early January 2008, Ambac announced that it was taking a $5.4 mark-to-market loss on its CDO portfolio, that it was taking a $1.1 credit impairment charge, and that it expected a net loss for the quarter. The company also announced the resignation of the company’s CEO. The company’s share price declined, and two days later the company received the first of several rating downgrades from the rating agencies.

 

As noted here, the plaintiffs first filed their complaint in January 2008. In their ’34 Act claims, in which the defendants named are the company and certain of its directors and officers, the plaintiffs allege that the defendants mislead investors by continuing to portray Ambac’s underwriting procedures as cautious and conservative, while failing to disclose that the company had lowered its underwriting standards; by stating that Ambac was actively monitoring its RMBS and CDO portfolios and that the portfolios continued to outperform; and by failing to disclose in a timely manner any material impairment to the RMBS-related instruments that Ambac insured.

 

In their ’33 Act claims, which the plaintiffs asserted against the company and certain of its directors and officers, as well as against the offering underwriters and the company’s outside auditor (KPMG), the plaintiffs allege that the defendants made misleading statements in the offering documents about the company’s underwriting standards as well as regarding the company’s RMBS and CDO-related exposures.

 

The defendants moved to dismiss.

 

The February 22 Ruling

In rejecting the defendants’ motions to dismiss the ’34 Act claims, Judge Buchwald found that "the plaintiffs allegations of recklessness support a strong inference of scienter" for each of the ’34 Act claim defendants.

 

Judge Buchwald cited numerous allegations which she found sufficient to show that Ambac’s officers were aware that "Ambac lowered its underwriting standards in several ways." Among other things, she cited an internal October 2006 email to one of the defendants asking "Why are we willing to insure stuff in the secondary market [i.e., the CDO market] that we would not touch with a ten foot pole in the primary market [i.e., the RMBS market]?"

 

Judge Buchwald also found that the officers’ own public statements "detail the regular reports by which they would have learned of the allegedly drastic deterioration of their CDO portfolio." She went on to note that in various public statements the officers "themselves described in the means by which the raw material was collated and analyzed, as part of the surveillance process, and how this formed the basis for defendants’ statements."

 

In concluding that the plaintiffs had adequately pleaded recklessness, she rejected the alternative inference that the defendants urged her to draw from the allegations, namely that the officers could not have predicted the economic collapse and therefore the company’s modeling tools failed to identify the risk of loss in the CDO portfolio. In reaching this conclusion she noted:

 

Viewing the allegations collectively, there is a vast gap between the picture that Ambac presented to investors – of an insurance company that maintained its conservative approach over the years – and the alleged practices within the company, namely the undisclosed lowering of underwriting standards to drive short-term profits. Additionally, defendants’ arguments on this issue are premised on a convenient confusion of cause and effect. The conduct that plaintiffs’ allege, if true, would make Ambac an active participant in the collapse of their own business, and of the financial markets in general, rather than merely a passive victim.

 

Judge Buchwald also found that the plaintiffs had adequately alleged misrepresentation and loss causation. Interestingly, in concluding that the plaintiffs had adequately alleged misrepresentation in connection with the CDO valuation issues, Judge Buchwald cited and apparently relied on the characterization of the company’s CDO portfolio in the plaintiff’s expert analysis, an interesting step at the motion to dismiss stage.

 

Finally Judge Buchwald held that the plaintiffs’ complaint adequately stated a ’33 Act claim with respect to the company’s February 2007 offering, but failed to state a claim with respect to the company’s March 2008 offering because the alleged misstatements in connection with that offering are not actionable under the "bespeaks caution" doctrine.

 

In allowing the claims relating to the February 2007 offering to go forward, she expressly rejected the defendants’ statute of limitations arguments, holding that the "storm warnings" on which the defendants sought to rely were not sufficient to put the plaintiffs on "inquiry notice," because Ambac’s officers had actively sought to reassure investors about those supposed storm warning.

 

Discussion

Judge Buchwald’s ruling in this case is interesting and perhaps significant in a number of respects.

 

First, reliable sources in the plaintiffs’ bar advise me that Judge Buchwald is viewed as a tough draw for plaintiffs. These same sources advise that the fact that she is the one that wrote the opinion makes it even more noteworthy.

 

Second, I think her language in rejecting the "hey, the whole economy tanked" argument is important. There are a number of companies about whom it might be alleged, as was alleged here of Ambac, that they were "an active participant in the collapse of their own business, and of the financial markets in general, rather than merely a passive victim." In other words, the general collapse of the financial markets alone might not be enough to refute the potential existence of fraud, if the plaintiffs sufficiently allege that the defendant companies nevertheless contributed to their own collapse.

 

This is significant because many companies that have been sued in the wake of the credit crisis have tried to refute the inference of fraud by arguing that that no one could have foreseen what subsequently happened. However, as Judge Buchwald noted, the collapse was not the result of the operation of some inevitable physical force. While there were many factors that contributed to the collapse, one of the causes may well have been various companies’ actions and statements prior to the collapse.

 

The fact that the subsequent collapse was generalized is not necessarily inconsistent with the possibility that prior to the collapse that fraudulent misconduct may have taken place at any one specific company – or, as Judge Buchwald noted, that the misconduct may have helped bring the collapse about.

 

I also think Judge Buchwald’s rulings are interesting because of her willingness to rely on plaintiffs’ expert’s analysis in finding misrepresentations on the CDO valuation issue and also because of her rejection of the statute of limitations argument based on the contention that "storm warnings" put the plaintiffs on "inquiry notice."

 

But the final reason that Judge Buchwald’s ruling may be significant is that it is a very strong opinion ruling in the plaintiffs’ favor in a high profile subprime-related case in the Southern District of New York. So many of the subprime related cases are pending in the Southern District, so the plaintiffs lawyer will of course seek to rely on Judge Buchwald’s holdings in other cases pending in that District.

 

It of course remains to be seen to what extent plaintiffs will be able to get mileage out of Judge Buchwald’s holdings in other cases. But it does in any event represent a significant victory for the plaintiffs.

 

I have added the Ambac decision to my table of subprime and credit crisis-related securities class action lawsuit dismissal motion rulings, which can be accessed here. It certainly does seem that recently the dismissal motion rulings have been coming down fast and furious.

 

Special thanks to a loyal reader for providing me with a copy of the Ambac decision.

 

Climate Change and D&O Coverage: In a recent post (here), I noted the possibility that the requirements of the SEC’s new interpretive guidance about climate change disclosure could create a context within which climate change disclosure claims might arise. If these kinds of claims do materialize, they potentially could create important coverage issues under applicable D&O insurance policies.

 

A February 19, 2010 memo by Collin Hite and Sung Yhim of the McGuire Woods law firm entitled "Global Warming Litigation and D&O Insurance Coverage Issues" takes a look at the kinds of coverage issues that might be involved if climate change-related disclosure cases do arise. The memo can be found here.

　

Just when it seemed as if the dismissal motion rulings in the subprime-related securities suits might be breaking more favorably to the plaintiffs, two February 18, 2010 rulings granted the defendants’ motions to dismiss in two separate subprime cases. While only one of the two dismissals was with prejudice, both represent substantial defense victories. These latest rulings tend to support the view that, with some notable exceptions of course, the plaintiffs are as a general matter facing hurdles in many of the subprime cases.

 

Fortis: In a February 18, 2010 decision (here) that addressed recurring issues of the extraterritorial jurisdiction of U.S. courts under the U.S. securities laws, Southern District of New York Judge Denny Chin dismissed the subprime-related securities suit pending against Fortis and certain of its directors and officers, for lack of subject-matter jurisdiction.

 

As I detailed in a prior post about the Fortis lawsuit (here), Fortis is a Belgium-based financial company that in late 2008 received a massive bailout by the governments of Belgium, the Netherlands and Luxembourg. Fortis’ shares trade on several European exchanges and its ADRs trade over-the-counter in the U.S.

 

In their amended complaint, the plaintiffs allege that the defendants misrepresented the value of its collateralized debt obligations; the extent to which its assets were held as subprime-related mortgage backed securities; and the extent to which its ill-fated decision to acquire ABN-AMRO had compromised the company’s solvency.

 

In granting the motion to dismiss, Judge Chin found, applying the Second Circuit standard articulated in the National Australia Bank case, that the plaintiffs had not alleged either sufficient U.S.-based "conduct" or "effects" to support the court’s exercise of subject matter jurisdiction.

 

Specifically, the found that the company’s alleged New York-based data compilation was merely preparatory to the actual fraudulent misrepresentations, which were alleged to have been made by the company’s executives in Brussels. Judge Chin found that "the complaint describes the Brussels executives as the masterminds, and portrays the New York Office as uninvolved in decision-making regarding information to be communicated."

 

In finding that the complaint failed to satisfy the "effects" test, Judge Chin observed that the "lead plaintiffs do not explicitly allege what percentage of Fortis’s investors are U.S residents, nor the effect the fraud may have had in the United States."

 

Judge Chin noted that the complaint alleges that 17.2% of all institutional investors were located in North America, but "it does not break down what percentage of those were located in the U.S. – as opposed to Canada, Mexico or any of the approximately 38 countries on the continent."

 

In closing, Judge Chin denied plaintiffs leave to amend, noting that "plaintiffs have already had two bites of the apple, as they have already filed two complaints," adding that "it is difficult to imagine that plaintiffs did not allege all the facts they had a good faith basis for asserting," and a "third opportunity to plead would be futile."

 

Judge Chin’s refusal in the Fortis case to allow the plaintiffs’ to file an amended complaint stands in contrast to what happened in the Credit Suisse case, where, as I discussed here, Judge Victor Marrero at least allowed the plaintiffs to seek leave to file an amended complaint. Significantly, in the Credit Suisse case, the plaintiffs were able to present sufficient additional allegations to satisfy the "effects" test and to establish subject matter jurisdiction. Judge Chin’s refusal even to allow plaintiffs to seek leave to amend, and possibly to cure the pleading defect, stands in contrast to the Credit Suisse case.

 

MGIC: In a February 18, 2010 order (here), Eastern District of Washington Judge Lynn Adelman granted the defendants’ motion to dismiss in the subprime-related securities suit that had been filed against mortgage insurer MGIC Investment Corporation and certain of its directors and offices, as well as against certain officers of C-Bass, a subprime mortgage-securitizer in which MGIC was a joint venture partner with Radian Group.

 

In their complaint, the plaintiffs alleged that the MGIC defendants had misrepresented MGIC’s underwriting practices; that the MGIC defendants had misrepresented the performance of mortgages the company had insured in 2005 and 2006; and that the defendants had misled investors about the extent of C-Bass’s margin calls in July 2007.

 

Judge Adelman went through each of the allegedly misleading statements on which the plaintiffs sought to rely, and with respect to each, he found that the statements were either immaterial or not misleading, or even if misleading, that the plaintiffs had failed to establish that the statements had been made with scienter.

 

Judge Adelman granted the plaintiffs leave to amend, should they choose to do so. However, it will be very challenging for plaintiffs to overcome all of the concerns Judge Adelman noted. The very detailed, painstaking and comprehensive way that Judge Adelman considered each of the alleged misrepresentations may leave plaintiffs with very little room to try address his concerns.

 

In any event, the subprime-related securities suit filed against the other C-BASS joint venture partner, Radian Group, was previously dismissed, as discussed here.

 

Discussion

The plaintiffs’ difficulties trying to establish subject matter jurisdiction in the Fortis case are significant, because many of the other subprime-related cases also involve foreign-domiciled companies. Perhaps the pleading differences between the Credit Suisse case (where the plaintiffs had specifically identified the percentage of shares held by U.S. institutional investors) and the Fortis case provide plaintiffs in other cases enough of a road map, but the Fortis case still does suggest that plaintiffs may struggle to establish jurisdiction in many of these cases.

 

The difference in outcomes in the two cases may be a reflection of where each company’s ADRs traded. Credit Suisse’s ADRs traded on the NYSE, but Fortis’s ADRs traded only over the counter. As Ben Hallman noted in his February 19, 2010 Am Law Litigation Daily article (here) discussing the Fortis decision, over the counter purchases are "nearly impossible to track," and accordingly "the damage to U.S. investors impossible to quantify." The plaintiffs in subprime cases against other non-U.S. companies whose shares or ADRs do not trade on one of the formal U.S. exchanges may have similar difficulty quantifying the impact on U.S. investors.

 

One interesting related question is the extent to which the outcome of the National Australia Bank case, now pending before the U.S. Supreme Court, might affect these jurisdictional issues. Congress may also have its own say on these issues. The bottom line is that there are a lot of moving pieces that could affect consideration of these jurisdictional issues going forward.

 

In any event, these two dismissal motion rulings represent that much more evidence that overall plaintiffs do not seem to be faring particularly well in the subprime-related securities suits. As reflected on my running tally of the subprime and credit crisis-related dismissal motion ruling, which can be accessed here, the defendants have prevailed in far more motion rulings to date than have the plaintiffs.

 

Though plaintiffs have had some notable victories, and though plaintiffs have even managed to survive some renewed motions to dismiss after initial dismissal motions had been granted, in the majority of motion rulings, the defendants have prevailed. By contrast to historical patterns, where cases are dismissed somewhere between 33% and 40% of the time, in the subprime-related dismissal motion rulings, the defendants are prevailed about two-thirds of the time – at least so far. Many of the subprime and credit crisis cases have still not yet reached the dismissal motion stage.

 

So Many Updates, So Little Time: With all of the voices and sources, who is worth following? Bruce Carton, the author of the Securities Docket blog and a new media maven in the securities enforcement arena has put together an updated list of the 15 "must-follows" on Twitter. Special thanks to Bruce for including me on his list.

 

Some Winter Olympics Observations:

1. The key physical forces involved in the winter Olympics sports are the coefficients of friction and aerodynamic drag. (Contrary to what some might think, "aerodynamic drag" is not a description of Johnny Weir’s skating attire.)

2. Shaun White really did say, on camera, while describing his emotional state, "freaky deeky."

3. "Live curling." Discuss.

4. With reference to the commercial in which the female snowboarder leaves the earth’s atmosphere: (a) Does anybody have any idea what product or service is being advertised? (b) Where is she supposed to be snowboarding, the edge of some gigantic cosmic womb or something like that? (c) Am I the only one who is troubled that she never returns to earth, but instead drifts off further into the ether… it all seems so sad and weird.

5. In the summer Olympics, it was commercials with wind turbines. Now in the winter Olympics, it is commercials with girl ice hockey players.

6. Shen Xue and Zhao Hungbo not only came out of retirement to win gold in pairs figure skating, but they did something even more amazing – they managed to get us to root for a couple of Chinese athletes. (If you think that sounds xenophobic, just imagine how it is going to feel four years from now when Chinese snowboarders sweep the medals in the half pipe.)

7. In the entire history of the human race, from the dawn of man to the present moment, has there ever been anyone more unfortunately named than Dick Button?

 

As the number of failed banks has surged over the past couple of years, one anticipated byproduct has been a corresponding wave of litigation against the failed institutions’ former directors and officers. The thing is, the anticipated wave really has not yet materialized. But nevertheless some suits are coming in, as demonstrated most recently in a new lawsuit filed this past week against certain former directors and officers of a failed Georgia bank.

 

On February 18, 2010, seventeen individual plaintiffs (including one trust) filed a Verified Complaint (here) in Cobb County (Ga.) Superior Court against three former directors of Alpha Bank and Trust, an Alpharetta, Ga. bank that failed on October 24, 2008. A February 18, 2010 Atlanta Journal-Constitution article about the filing can be found here.

 

The bank, according to press reports, was "one of the quickest bank failures in the nation in recent years, losing almost half of its assets after only 29 months in business."

 

The plaintiffs’ complaint seeks recovery for negligent misrepresentation and alleges that the three defendants had possession of material information about the bank that they failed to disclose to the plaintiffs, who owned shares in the bank.

 

There are a number of interesting things about this complaint. The first is that in paragraph 10, the complaint expressly purports to "exclude and disclaim any allegations whatsoever that could be construed as alleging or sounding in" the federal securities laws; common law fraud; intentional, knowing or reckless misconduct; breach of fiduciary duty, or mismanagement.

 

Clearly, the plaintiffs are not only aiming to avert procedural hurdles and potential defenses, but, as discussed below, they are also trying to circumvent the FDIC’s priority rights under FIRREA to claims the FDIC acquired as the bank’s receiver.

 

Second, the specific misrepresentations alleged – that the bank experienced undisclosed regulatory difficulties almost from its very beginning, that the bank submitted an undisclosed revised business plan to regulators, that the bank’s board dismissed the bank’s CEO for undisclosed reasons, among other things – all took place after the bank was launched and apparently after the plaintiffs’ acquired their shares.

 

As a result, plaintiffs’ claim is not that the they were misled into investing in the bank in the first place, but rather that as a result of a series of allegedly wrongful omissions, they "continued to hold their substantial respective investments," as the complaint puts it. A "continued to hold" assertion is a more challenging claim that an "induced to buy" argument.

 

Third, as suggested above, the plaintiffs clearly tried to shape their allegations in order to avert the FDIC’s rights as receiver to priority over all of the failed institution’s claims. (Refer here for my prior post discussing the FDIC’s right under FIRREA.) The plaintiffs have very carefully alleged that they seek to "recover individualized damages," as well as explicitly asserting that they are not alleging breach of fiduciary duty or mismanagement, which are claims to which the FDIC’s priorities would be clearest.

 

The FDIC may yet of course attempt to assert its right to priority over the claims the plaintiffs have asserted, and even assert its own claims, based on its status as the bank’s receiver. A recent memo from the Alston & Bird firm (here), citing the FDIC’s own statistics, reports that "of the financial institutions that failed in the period between 1985 and 1992, the FDIC initiated claims against the former directors and officers of 24 percent of those institutions."

 

There is absolutely no reason to expect that the FDIC will prove to be less litigious now than it was during the S&L crisis. So there would seem to be a considerable possibility the FDIC could yet assert its own claims, as receiver, against the former Alpha Bank officials.

 

Whether the existing investor claim or any future FDIC claim might succeed remains to be seen. However, were the FDIC to pursue a claim as receiver, and if it were unable to assert its priority under FIRREA over the investors’ claim, there could be a race to capture assets from which to recover – the most obvious asset being the D&O policy. A potential barrier under the D&O policy to any recovery by the FDIC would arise if the applicable policy has a regulatory exclusion.

 

Whether any successful claimant would be able to recover under the D&O policy will depend further on whether or not anything is remaining when the time arrives. If there were to be litigation free-for-all, defense costs alone could substantially erode the available insurance.

 

Finally, in terms of the anticiapted litigation wave, it is worth noting that approximately 16 months elapsed between the time Alpha Bank failed and the date the investors filed their suit against the former bank officials. Most of the closures of the most of the banks that have failed as part of the current banking crisis have failed more recently than Alpha Bank. The litigation may yet arrive, it may just follow more slowly than might have been anticiapted.

 

Special thanks to the several loyal readers who forwarded copies of the Alpha Bank complaint to me.

 

Belated Securities Suit Filings (Extreme Edition): In a number of recent posts (most recently here), I have noted the curious phenomenon of securities class action lawsuits that are filed well after the proposed class period cut off date. In some cases, the filing has come well over a year after the alleged stock price drop. However, a recent filing seems to set some kind of a belatedness record, as the complaint was filed nearly four and a half years after the proposed class period cutoff date.

 

In a complaint filed on February 18, 2010 against certain former directors and officers of the bankrupt Dana Corporation (here), the proposed class period runs from February 23, 2005 to October 7, 2005. The class period starting date is just short of five years, which is represents the period of the statute of repose for ’34 Act claims.

 

A great deal of context is necessary just to try to start to make sense of what might be going on here. First, there already is an existing securities class action lawsuit pending against other former directors and officers of Dana. The prior case, about which refer here, was first filed in the Northern District of Ohio in October 2005 and was dismissed with prejudice in August 2009 (here). The appeal of the dismissal is currently pending in the Sixth Circuit.

 

A knowledgeable observer suggested to me that the plaintiffs’ lawyers may think they have uncovered new facts implicating the four lower level defendants that are named in the new case. The speculation is that the plaintiffs’ lawyers filed the new case against the four new defendants to preserve the statute of limitations while the "main case" is on appeal. Because of the prior dismissal, the plaintiffs’ lawyers couldn’t just amend the previously existing complaint.

 

Where all of this might lead remains to be seen, but in the meantime the new complaint sets a new standard in superannuated securities lawsuit filings.

 

Special thanks to a loyal reader for sending along a copy of the new Dana complaint.

 

After an initial flurry of bank failures in January, the pace of bank closures more recently has slowed. There has been only one failed bank so far in February, and there were none at all this past Friday night, the first failure-free Friday in several weeks. The apparent bank closure slowdown does not, however, mean that the worst is past; indeed, if a recent Congressional watchdog committee report is accurate, there may be many, many more bank failures ahead.

 

The Congressional Oversight Panel was created to oversee the expenditure of TARP funds and provide recommendations on regulatory reform. The Panel is chaired by Harvard Law Professor Elizabeth Warren.

 

On February 10, 2010, the Panel released its 190-page February Oversight Report, entitled "Commercial Real Estate Losses and the Risk to Financial Stability." The Report can be found here, and the Panel’s February 11, 2010 press release about the Report can be found here.

 

The Report paints a dire picture of the current and likely future performance of outstanding commercial real estate loans. The Report begins by observing that the Panel is "deeply concerned that commercial loan losses could jeopardize the stability of many banks, particularly the nation’s mid-size and smaller banks, and that as damage spreads beyond smaller banks that it will contribute to prolonged weakness throughout the economy."

 

The fundamental problem is that between 2010 and 2014, about $1.4 trillion in commercial real estate loans will reach the end of their terms. Nearly half are "underwater," meaning that the borrower owes more than the property is currently worth.

 

The commercial real estate borrowers’ problems are two-fold. The weakened economy means that the borrowers are having problems realizing sufficient cash from the properties to cover their principal and interest obligations (or, to give the problems its technical name, to maintain their "debt service coverage ratio"). The deeper problem is that when their debt obligation matures, they won’t be able to refinance the loan due to tougher bank underwriting standards or property value decreases.

 

Figure 31 on page 72 of the Report graphically illustrates the problem. The bar graph shows that commercial mortgage maturities will hit their highest levels between 2010 and 2014, with the peak coming during 2012 and 2013.

 

The timing of the debt maturities is all the more unfortunate, because they arise as signs point to continued (and perhaps progressively worse) deterioration of real estate market fundamentals. As the Report notes, "commercial real estate metrics tend to lag overall economic performance." For the last several quarters vacancy rates have risen and average rental prices have fallen for all major commercial property types.

 

Unless the nascent economic recovery picks up sufficient momentum to reverse these negative trends, the likelihood is that many of the maturing real estate loans will fail. Which means trouble for many smaller banks.

 

According to the Report, 2,988 of the roughly 8,100 U.S banks have a "CRE Concentration," meaning that such loans represent at least 300% of total capital or that construction and land loans exceed 100% of capital.

 

The danger is not just to the banks, according to the Report; rather, because of the downward spiral that defaults trigger, "a significant wave of commercial mortgage defaults would trigger economic damage that could touch the lives of nearly every American."

 

The Report is neutral on the possibility whether an economic recovery could avert the worst of these concerns, saying only that "there is no way to predict with assurance whether an economic recovery of sufficient strength will occur to reduce these risks before the large-scale need for commercial mortgage refinancing is expected to begin in 2012-2013." The Report urges the Treasury and the banking regulators to "take coordinated action to address forthrightly and transparently the state of the commercial real estate markets."

 

Although the Report itself does not address this issue, an accompanying problem that is exacerbating these issues for many smaller banks is the banks’ past issuance of "trust preferred securities" to raise capital and fund loans. As I discussed at greater length here, these hybrid debt-equity instruments were a popular way in recent years for many banks to raise funds. Between 2000 and 2008, more than 1,500 small and regional banks issued about $50 billion in trust preferred securities, according to a February 12, 2010 Wall Street Journal article (here).
 

 

But as the current banking crisis has unfolded, certain features of these securities have operated to magnify many banks’ woes. The first is that the buyers of these instruments were in many cases other banks. As the issuing banks’ finances have deteriorated, the value of the instruments to the investor banks has also declined. Indeed, the deteriorating value has contributed to the demise of at least some of investor banks (about which refer here).

 

As the Journal article itself notes, these instruments give the buyers certain preferences. However, the existence of these preferences, which ensure that the holders of the instruments would be first in line to recover losses, means that other prospective investors now are wary of making any further investments, for fear that their investments would be subordinated to the trust preferred securities holders. These circumstances leave some banks unable to raise additional capital, "increasing the possibility that some of the weakest banks could fail."

 

Many banks are trying to repurchase their trust preferred securities at steep discounts, in a bid to circumvent these problems, but many of the holders (in many cases, other banks with their own problems) are reluctant to sell and be forced to recognize and absorb their losses. As the Journal article notes, "the standoff is particularly perilous for banks that are reeling from deteriorating real-estate portfolios."

 

The bottom line is that many banks will face daunting circumstance possibly for several years to come. These concerns in turn present a challenge for D&O insurance underwriters as they struggle to assess the risk exposures associated with these financial institutions. Whatever else might be said, it does seem likely that the current unsettled D&O insurance marketplace for lending institutions will continue.

 

As one time, and for many years, I was responsible for managing a team of D&O underwriters. If I were managing D&O underwriters today, particularly if our portfolio of risks included lending institutions, I would require all of my underwriters to read the Congressional Oversight Panel’s latest Report. It makes for some sobering reading.

 

Other Important Information: How to tell if your cat is plotting to kill you. Read it here.

　

In an interesting February 11, 2010 decision (here), Southern District of New York Judge Victor Marrero allowed plaintiffs, whose subprime-related securities class action lawsuit Marrero had previously dismissed, leave to file a second amended complaint against Credit Suisse Global and certain of its directors and officers.

 

Judge Marrero also found the securities fraud allegations in the proposed amended complaint to be legally sufficient, meaning that the claims can now go forward, although he also ruled that the court lacked jurisdiction over the claims of plaintiffs that resided outside the U.S. and that had purchased their shares outside the U.S.

 

Background

Credit Suisse is domiciled in Switzerland. Its shares trade on several securities exchanges outside the U.S. and its ADRs trade on the NYSE. As reported in greater detail here, the plaintiffs filed their initial complaint in this action in April 2008. The plaintiffs alleged that the defendants had made material misrepresentations about the company’s asset valuation system, its internal controls (which allegedly allowed unauthorized placement of high risk mortgage-backed assets in client accounts), and its own exposure to losses related to subprime mortgages.

 

In an October 5, 2009 order (here), Judge Marrero had previously granted the defendants’ motion to dismiss, on the grounds that the court lacked subject matter jurisdiction over the claims of claimants who reside outside the U.S. and who had purchased their shares on foreign exchanges (so-called f-cubed claimants). The complaint had not identified the domicile of some other named plaintiffs, but Judge Marrero dismissed their claims as well.

 

In his prior ruling he required plaintiffs to seek leave to file an amended complaint, which the plaintiffs did. His February 11 opinion addressed the plaintiffs’ motion for leave to file an amended complaint.

 

The February 11 Opinion

In his February 11 decision, Judge Marrero granted the plaintiffs’ motion for leave to file their amended complaint, at least as to certain of the claimants.

 

Judge Marrero first found that the amended complaint failed to establish subject matter jurisdiction as to the foreign domiciled claimants that had purchased their shares on foreign exchanges. In reliance on the Second Circuit’s National Australia Bank standard (about which refer here), he found that because the alleged misrepresentations had originated in Switzerland, there was insufficient U.S.-based conduct to support the court’s exercise of subject matter jurisdiction over the claims of the non-U.S. claimants.

 

However, Judge Marrero found that the amended complaint contained sufficient allegations to permit the exercise of jurisdiction as to the claims of the U.S.-based claimants. The amended complaint alleged that more than 75 million Credit Suisse shares were held by institutional investors, representing over 11% of shares outstanding, and therefore there were sufficient "effect" alleged within the U.S. to support jurisdiction.

 

Judge Marrero then proceeded to determine that the plaintiffs’ securities fraud allegations were legally sufficient. Among other thing, he found that though the proposed amended complaint "contains much extraneous detail and irrelevant information," within the "remaining core of what is pertinent" the plaintiffs’ proposed complaint "sufficiently alleges scienter."

 

The proposed complaint relies heavily on confidential witness statements, from which Judge Marrero determined that the proposed complaint "alleges sufficient facts showing that the Defendants had direct knowledge of information contradicting their public statements or access to similar statements they should have monitored." Judge Marrero concluded that the proposed complaint properly pled scienter to support theories of fraud based on alleged schemes to "overvalue assets, underestimate risk, hide subprime exposure, ignored weaknesses of [the company’] risk management and internal controls, and violate GAAP."

 

Discussion

As a result of Judge Marrero’s February 11 ruling, the Credit Suisse Group subprime-related securities case, which had initially been dismissed, will now go forward. The Credit Suisse case is the latest in a series of subprime-related securities suits in which dismissal motions were initially granted, but in which the amended complaints later survived renewed dismissal motions. This list of cases in this series includes the PMI Group case (here), the Washington Mutual case (here), and the BankAtlantic Bancorp case (here).

 

The ability of the plaintiffs in these cases to cure initial pleading deficiencies and to overcome preliminary pleading hurdles is noteworthy. Among other things, it casts important light on the list of subprime-related securities cases in which motions to dismiss have been granted. Many of these dismissals are without prejudice, meaning that the plaintiffs in a number of these cases, like the plaintiffs in the Credit Suisse case, may yet find a way to survive renewed dismissal motions and live for another day.

 

The outcomes of many of the dismissal motion rulings (at least to this point) the subprime-related securities cases could possible be interpreted to suggest that the cases were not faring particularly well. As reflected in my table of subprime-related lawsuit dismissal motion rulings, which can be accessed here, of the 48 subprime-related securities lawsuits in which dismissal motion rulings had been entered, fully 31, or nearly 65%, had resulted in the dismissal motions being granted, a dismissal rate the far exceeds typical patterns.

 

However, in 16 of the 31 cases, the dismissals were without prejudice. Many of the cases in which dismissal motion motions have been granted may yet survive renewed dismissal motions.

 

In any event, there still have only been dismissal motion rulings in about 27% of the subprime and credit crisis-related securities suits. The dismissal motions have not yet heard in nearly three quarters of the subprime and credit crisis-related securities suits. Though the subprime litigation wave first started in February 2007 and is now entering its fourth year, it still has a very long way to run. And many cases yet to be heard and other cases surviving renewed motions to dismiss, it is far too early to try to say one way or the other that cases are or are not faring well.

 

The fact that the Credit Suisse claims involve a foreign-domiciled corporate defendant is also noteworthy. Many of the subprime-related securities cases involve non-U.S. companies. the Credit Suisse case show that in at least some of these cases against foreign companies, the plaintiffs will succeed in establishing jurisdiction, even if the allegedly misleading statements originated outside the U.S., although in those cases the claims of foreign domiciled investors who purchased their shares on foreign exchanges may or may be allowed to continue.

 

Many thanks to a loyal reader for sending me a copy of the Credit Suisse decision.

 

Speaking of Jurisdiction Over Foreign-Domiciled Companies: One of the ways in which companies domiciled outside the United States can, in at least some kinds of cases, seek to avoid the burden and risk of defending litigation in the United States is by asserting the principle of forum non conveniens. This judicial tenet allows a court to defer jurisdiction where principles of justice and convenience favor the action being brought in another forum.

 

A February 2010 memo by the Sherman & Sterling law firm (here) discusses this principle and analyzes its recent application in the Cadbury Shareholder Litigation, a purported derivative class action that had been filed in connection with Kraft Foods hostile takeover bid. The action was brought in New Jersey federal court though Cadbury is a U.K. company, U.K law governs the Board’s conduct, and none of the parties resided in New Jersey.

 

In the Cadbury case, the court granted the defendants’ motion to dismiss on forum non conveniens grounds, determining among other things that the U.K. was an adequate alternative forum and that the plaintiffs’ choice of forum was entitled to little deference. The court also found that the differences between U.K. and U.S. takeover law did not detract from the availability of an adequate alternative forum in the U.K.

 

The principles of forum non conveniens could provide a substantial defense in other derivative litigation involving foreign domiciled companies. It is less likely to be relevant in class action cases alleging violations of the U.S. securities laws, as the availability of an adequate alternative forum may be far less likely given the absence in many jurisdictions of adequate alternatives to the remedies available under the U.S. securities laws.

 

In any event, the recent decision in the Cadbury case represents yet another case in which U.S. courts have sought to determine the circumstances under which it is and is not appropriate for U.S. courts to exercise jurisdiction over foreign-domiciled companies.

 

Bankruptcy Court Did Not Abuse Discretion in Granted Relief From Automatic Stay Allowing D&O Insurer to Reimburse Individual’s Defense Expenses: In an opinion filed on January 29, 2010 (here), the Ninth Circuit Bankruptcy Appellate Panel held that the bankruptcy court did not abuse its discretion in granting relief from the automatic stay in bankruptcy to allow the company’s D&O insurer to advance an individual insured’s legal expenses.

 

Layne Sapp had been the sole director, chief executive officer and majority shareolder of MILA, Inc., a mortgage brokerage firm. The company had a $1 million D&O insurance policy. The company filed for bankruptcy and the trustee initiated an adversary proceeding against Sapp alleging a number of claims. Sapp incurred legal costs defending himself. The D&O carrier agreed to advance his defense expenses if Sapp obtained a comfort order stating that the Insurer was not violating the automatic stay by making the payments.

 

Sapp filed a request for relief from the automatic stay to allow the D&O insurer to pay his defense expense. The trustee opposed the motion on the ground arguing that the policy proceeds were estate property and that payment of Sapp’s defense expense would deplete the limits. (Oddly and unusually, MILA’s D&O policy did not have so-called entity coverage, so the Trustee’s assertions of the estate’s rights to the policy proceeds were limited to the company’s reimbursement coverage under Side B of the policy).

 

The bankruptcy court granted Sapp’s request and the Trustee appealed.

 

The appellate panel held that the bankruptcy court had not abused its discretion in granting relief from the stay. The appellate panel found that the bankruptcy court had appropriately weighed the parties’ respective harms and determined that Sapp had shown the requisite case for relief.

 

The debate about the right to D&O insurance policy proceeds in the bankruptcy context is a long-standing and sometimes vexatious issue. A good summary of the principles involved can be found in a 2006 memo by Wiley Rein’s Kim Melvin, here.

 

And Finally: A surprising number of people manage to figure this one out on their own without even requiring instruction — "How to Suck at Facebook" (here).

　

One of the most distinctive attributes of the 2009 securities class action lawsuit filings was the prevalence, particularly in the second half of the year, of new lawsuits in which the filing date came well after the date of the proposed class period cutoff. There has been much discussion over the cause of the belated filings. But whatever the reason may be for these filings, the phenomenon clearly has carried over into 2010, and at least so far seems to be a significant feature of the 2010 securities lawsuit filings.

 

The two new securities class action lawsuits filed on Friday, February 5, 2010 both represent this distinct class of cases.

 

First, as reflected in their press release (here), on February 5, plaintiffs’ lawyers filed a securities class action lawsuit in the Southern District of New York against Nokia and certain of its directors and officers, alleging that the defendants had misled the company’s ADR investors about delays and price competition the company was experiencing with respect to its communications handsets. Though the complaint (which can be found here) was not filed until February 5, 2010, the proposed class period cutoff date is September 5, 2008, well nearly a year and a half before the filing date.

 

Second, as reflected in their press release (here), on February 5, a different set of plaintiffs’ attorneys filed a securities class action lawsuit in the Southern District of New York against the Bermuda-based workers’ compensation insurer CRM Holdings, Ltd., and certain of its directors and officers, relating the company’s pricing and reserving practices. Though the complaint (which can be found here) was not filed until February 5, 2010, the proposed class period cutoff date is November 5, 2008, over a year before the filing date.

 

These latest lawsuit follow along behind two other seemingly belated lawsuits already filed this year. The proposed class period cutoff date in the securities class action lawsuit filed on January 15, 2010 against medical device company Stryker Corporation is November 13, 2008, over a year before the filing date.

 

The most extreme example among the belated 2010 filings is the securities class action lawsuit filed on January 21, 2010 against Motorola. The January 22, 2008 class period cutoff date is a full 1 year and 365 days before the filing date, bringing the new lawsuit just inside the two year statute of limitations for actions under the ’34 Act.

 

In addition to their apparent belatedness, these filings also have a number of other attributes. Most particularly, none of these cases seem related to the subprime meltdown and global credit crisis. Even though CRM holdings is in the financial services industry, the allegations in that case do not appear to related to the economic crisis.

 

To that extent at least, then, the belated securities lawsuit filings seem consistent with the theory, which some plaintiffs lawyers have advanced (as discussed here), that the reason for these lag filings is that throughout most of the last three years, the plaintiffs’ firms were preoccupied with filing subprime and credit crisis cases. Now that that filing wave has died down the plaintiffs firm, by their account, are turning back to cases that they backburnered.

 

The other theory about these belated cases, advanced most notably by Professor Joseph Grundfest (refer here), is that the plaintiffs’ lawyers are running out of meritorious cases so they are scraping the bottom of the barrel (my words, not his) to file cases that, based on his analysis of past lawsuit filings, are statistically more likely to be dismissed.

 

I don’t know for sure why these cases have been filed belatedly. All I can say is that it is a very distinct and observable pattern that clearly has carried over into the New Year. Among other things, these filing patterns create challenges for D&O underwriters, who will face a great deal of uncertainty about when a company that has experienced past issues may be "out of the woods." To borrow an auto racing analogy, it as if a yellow flag has been raised for all the cars on the track – proceed with caution.

 

One final note about these belated filings so far in 2010 is that at least the Nokia and the CRM holdings cases involve foreign domiciled companies – they are based in Finland and Bermuda respectively. The susceptibility of non-U.S. companies to securities litigation in U.S. courts is a hot topic right now, with the National Australia Bank pending before the U.S. Supreme Court and with the Vivendi jury verdict having just been returned. These latest lawsuits suggest that the incidence of U.S. securities lawsuits against non-U.S. companies will remain a hot button issue for the foreseeable future.

 

Fifth Circuit Stays Ruling that Stanford Group’s D&O Insurers Must Pay Defense Fees: As I noted in an earlier post (here), on January 26, 2010, Southern District of Texas David Hittner had ordered Stanford Financial Group’s D&O liability insurers to pay the defense expenses that former Stanford officers (including Allen Stanford) are incurring in connection with various legal matters arising out of the Stanford scandal.

 

However, according to a February 4, 2010 Houston Chronicle article (here), the Fifth Circuit Court of Appeals has entered a stay of Judge Hittner’s ruling. The article also reported that the Fifth Circuit has schedule oral argument on the legal issues in the case for February 25, 2010.

 

So the story goes on, with out any greater clarity on the question whether or not the individuals are entitled to have their defense fees paid by the company’s D&O insurance carriers. High-profile financial scandals make for some high stakes (and therefore fiercely litigated) coverage issues.

 

Hat tip to the Securities Docket (here) for the link to the Chronicle article

　

In a flurry of headline-grabbing events involving Bank of America last Thursday, the SEC announced the renewed settlement of its enforcement suit against the company, while at the same time New York Attorney General Andrew Cuomo announced his office’s initiation of a separate fraud action against the company and two former company officials. These high-profile developments pose a series of questions, not the least of which are the questions concerning the claims raised — or not raised — against the company officials, which in turn underscore some basic issues concerning the liability of individuals under the federal securities laws.

 

The first and most fundamental question is whether Southern District of New York Jed Rakoff will approve the current $150 million settlement, after previously rejecting the prior $33 million deal.

 

In his harshly worded September 14, 2009 opinion (here), Judge Rakoff rejected the prior settlement, finding that it was "neither fair, nor reasonable, nor adequate." He challenged the very premise of the deal, which he said "proposes that shareholders who were the victims of the Bank’s alleged misconduct must now pay the penalty for the misconduct."

 

Judge Rakoff further criticized the deal because the SEC did not explain why "it did not pursue charges against the Bank management or the lawyers who allegedly were responsible for the false and misleading proxy statements."

 

As Susan Beck of the AmLaw Litigation Daily points out in her February 4, 2010 article about the settlement (here, registration required), the renewed settlement seemingly does not address either of Judge Rakoff’s principal concerns. That is, the company is still proposing to settle the case at the expense of current shareholders. And the settlement does not address Rakoff’s earlier criticism of the SEC for failing to hold any individuals accountable.

 

Along the same lines, the WSJ.com Law Blog quotes (here) Duke Law Professor James Cox as saying "Either I’m hopelessly ignorant or this doesn’t address Rakoff’s concerns at all. Maybe they think Rakoff is getting senile in his old age. But I wouldn’t count on that."

 

The lack of SEC action against individual company officials is all the more evident because of the separate action the NYAG initiated virtually simultaneously with the SEC’s announcement of the renewed settlement. Cuomo’s lawsuit (here) not only names the company, but also names as defendants former BofA CEO Ken Lewis and former CFO Joseph Price. The New York action seemingly begs the question of why the SEC did not pursue claims against individuals, especially in light of Rakoff’s concerns.

 

There are some important considerations that need to be taken into account in contrasting the SEC’s and the NYAG’s respective actions. First of all, the SEC has said all along that the reason it did not pursue enforcement claims against individuals is because of concerns with its ability to satisfy scienter requirements. Indeed, in his September 14 opinion, Judge Rakoff expressly noted that the SEC had contended at that time that it had not pursued claims against individuals as "culpable intent was lacking because the lawyers made all the relevant decisions."

 

Thought the NYAG’s action asserts claims against two former executives, the legal basis of the claim is New York’s Martin Act. Unlike the liability provisions of the federal securities laws, the Martin Act does not require a finding that the individuals acted intentionally. The NYAG’s claims simply do not face the same pleading barriers as the SEC would if it were to pursue claims under the federal securities laws against company executives.

 

The challenge in substantiating claims under the federal securities laws against senior company officials even when their company was engaged in fraudulent misconduct was underscored in the recent Vivendi securities class action trial, where the jury found the company liable on all 57 counts, yet at the same time found the individual defendants not liable. In a post trial interview (here), the individual defendants’ trial counsel explained that this seemingly split verdict can be understood in part by the fact that the jury (defense counsel contend) was persuaded by the individuals’ testimony that they had not intended to mislead anyone.

 

The SEC’s reluctance to pursue the BofA executives and the odd split verdict in the Vivendi trial raise some interesting questions to ponder about the susceptibility of individuals to the imposition of liability under the federal securities law, although the lack of traction against the individual executives in those two cases may simply be a reflection of situation specific circumstances.

 

But in any event, the seeming contradiction between the SEC’s inaction against any individuals and the NYAG’s pursuit of the two executives may not be quite as first appears. Among other things, the SEC settlement and the NYAG’s lawsuit announcement were not in isolation from each other. To the contrary, Cuomo’s press release expressly references the SEC’s settlement and quotes him as saying that he support the SEC’s settlement.

 

The suggestion is that the two developments should not be viewed as in disjunction but rather as complementary. Perhaps the SEC will refer to the NYAG’s suit in response to Rakoff’s likely concerns with the settlement about the SEC’s inaction against individuals.

 

The most important differences between the SEC’s renewed settlement and the earlier version Rakoff rejected are that the latest deal represents significantly larger dollar amounts, and it also includes the company’s agreement to adopt certain corporate governance reforms.

 

The governance reforms arguably provide real value to the current shareholders. But even if the value to shareholders is substantial, the renewed deal still does not avoid Judge Rakoff’s earlier concerns that BofA’s shareholders are being forced to bear the cost for having been misled about the Merrill Lynch transaction. Indeed, the significantly larger dollar value of the renewed settlement seemingly exacerbates this very problem.

 

Given these concerns, it will be very interesting to see what Judge Rakoff does with the renewed settlement. It is very hard to read his September 14 opinion now and to think that this renewed settlement will fare any better than the prior version. It will be particularly interesting to see what Judge Rakoff’s response says about the fundamental notion of holding individuals accountable under the federal securities laws.

 

Broc Romanek’s post about the SEC’s renewed settlement on his CorporateCounsel.net blog (here) has some interesting observations about the role of corporate governance reforms within the resolution of SEC enforcement actions.

 

"Bump-Up" Claims Surge: Much ink has been spilled concerning the supposed decline in the number of securities class action lawsuit filings in 2009. But whether or not the class suits are in fact declining, another form of corporate litigation apparently is on the rise.

 

According to a February 4, 2010 Law.com article (here), there has been an "uptick in shareholder lawsuits over mergers and acquisitions." One source quoted in the article states that filings of those types of claims – referred to as "bump up" actions because they seek to increase the sale price – are up "at least 50 percent" over a few years ago.

 

The article also quotes Boris Feldman of the Wilson Sonsini law firm as saying that "plaintiffs lawyers are trying to replenish their inventory, because traditional securities suits have fallen." He goes on to say that "nature abhors a vacuum, so more and more plaintiff firms have been filing merger suits instead."

 

Many D&O insurance policies have express exclusions precluding coverage for the amount of any additional consideration paid to settle a bump up claim. Moreover, as I discussed at length in a prior post (here), some courts have held that there is no coverage for the additional consideration, even without respect to the exclusion. In many circumstances, however, defense costs at least may be covered.

 

Lehman Subprime-Related ERISA Suit Dismissed: In an earlier post (here), I noted that Judge Lewis Kaplan had dismissed liability claims filed against the rating agencies that had provided ratings opinions in connection certain Lehman Brothers securities offerings. In a separate opinion relating to the Lehman collapse, on February 2, 2010 Judge Lewis Kaplan also dismissed the subprime-related ERISA class action that beneficiaries had filed against former company officials. A copy of Judge Kaplan’s opinion can be found here.

 

In dismissing the case, Judge Kaplan held that the complaint failed to allege that the misconduct alleged against the eleven director defendants violated any fiduciary duties that the individuals had to plan beneficiaries. He further held that the complaint failed to allege that the sole remaining defendant (a member of the plan administrative committee) had any responsibility for or involvement with the company’s supposedly misleading disclosures, or any prior awareness of the company’s imminent collapse.

 

A February 3, 2010 AmLaw article discussing the opinion can be found here (registration required). I have in any event added the opinion to my list of subprime-related lawsuit dismissal motion rulings, which can be accessed here.

 

Lost Generation: If you have not yet seen it, you may want to take a couple of minutes to view the Lost Generation "mirror image" video. It is pretty bare bones, but is still makes an interesting statement. Hat tip to the CorporateCounsel.net blog for the link.

 

https://youtube.com/watch?v=42E2fAWM6rA%26hl%3Den_US%26fs%3D1%26

On February 5, 2010, BAE Systems announced (here) that it has entered separate settlements with the U.S. Department of Justice and the U.S. Serious Frauds Office, pursuant to which the company will pay a total of nearly $450 million to settle long-standing investigations of improper payments.

　

Under the U.S. plea deal, the company will pay $400 million to settle one charge of conspiring to make false statements and under the U.K. deal the company will pay a penalty of £30 and plead guilty to one charge of breach of duty to keep accounting stemming from a payment to a former consultant in Tanzania. A February 6, 2010 Wall Street Journal article discussing BAE’s entry into these deals can be found here.

 

The investigations surrounding BAE’s improper payments have been both very high-profile and very controversial. As discussed at length in a prior post (here), the most sensational aspects of the investigation have involved allegations involving the Al-Yamamah Saudi Arms deal, which allegedly involved improper payments to Prince Bandar bin Sultan, a member of the Saudi royal family. The propriety of the Serious Fraud Office’s decision to terminate that aspect of the BAE investigation was particularly controversial and eventually made its way to the House of Lords, which, as noted here, concluded that the SFO had properly exercised its authority to terminate the investigation, after a lower court had previously ruled that the SFO must reconsider its decision to terminate the investigation. The DoJ continued its investigation of the controverisal arms deal, however.

 

Given the controversy surrounding the BAE investigation, it is hardly surprising that, notwithstanding the sheer size of BAE’s deals resolving the investigation, questions about the resolution of the investigation have arisen.

 

Among others concerns that have been noted, it is very difficult to discern from BAE’s press release and from the SFO’s release (which can be found here) which exactly the company is admitting to having done. Neither document contains words or phrases you might, under the circumstances, expect to see, including, for example, "bribery" "corruption" or even "improper payments" or "improper influence." As the FCPA Professor blog notes here, "can the enforcement agencies on both sides of the Atlantic say with a straight face that this case was merely about improper record keeping, making false statements to the government, and export licenses?"

 

The criminal information that the Department of Justice filed in the District Court for the District of Columbia is a little more specific, as it as least refers to improper payments that the company made in connection with military aircraft transactions involving the governments of the Czech Republic and Hungary. The criminal information also specifically references "undisclosed payments associate with the sale of Tornado Aircraft and other defense materials to the Kingdom of Saudi Arabia." The criminal information also specifically references "substantial benefits" provided to one unnamed Saudi official "who was in a position of influence" regarding the aircraft deals.

 

According to the FCPA Blog (here), the Al-Yamamah arms deal, about which the blog has additional information (including a link to video footage) is "at the heart" of the criminal information, though the details are slight.

 

The paucity of detail almost ensures that controversy will continue to surround the investigation. The tenor of the controversy is succinctly captured by the FCPA Professor blog’s comment in connection with the BAE deals that "transparency, corporate accountability, and indeed a criminal justice system all suffered setbacks today."

 

But though questions will continue to be raised, the sheer size of the payments BAE has agreed to make in order to resolve these investigations should not be overlooked. Along with the staggering amounts to which Siemens agreed to pay in connection with its own separate corrupt practices investigation, these payments demonstrate that corrupt practices investigations represent a very significant risk exposure. It should also not be overlooked that in the case of Siemens and BAE, as well as a number of other companies that U.S. authorities have targeted, these corrupt practices investigations often involved companies domiciled outside of the United States.

 

As I have previously noted (here), one parallel threat accompanying threat of regulatory investigations concerning corrupt payments is the possibility of follow-on civil litigation in U.S. courts. BAE systems was itself the target of a shareholders’ derivative suit regarding the corrupt payments investigation, although as noted here (scroll down after linking), the BAE Systems derivative suit was later dismissed due to the claimants lack of appropriate standing to bring the action.

 

Other foreign targets of FCPA investigations have also been subject to civil litigation in U.S. courts, as demonstrated by the recent securities lawsuit filed against Panalpina and certain of its directors and officers concerning its disclosures and accounting for certain alleged improper payments.

 

The point is that not only does the threat of an improper payments investigation represent a significant risk exposure for companies active in the global economy but that threat includes the risk of civil litigation in U.S. courts. This litigation threat all of these issues important considerations for purposes of D&O insurance, as I discussed in a prior post, here.

 

On February 2, 2010, the SEC published its interpretive release providing guidance to public companies on the SEC’s existing disclosure requirements as they apply to climate change. The release can be found here. A February 4, 2010 memo from the Gibson Dunn law firm analyzing the SEC’s release can be found here.

 

While the interpretive release take pains to emphasize that it only clarifies existing obligations, the release nevertheless represents the Commission’s clearest statement about expectations for public company’s climate change disclosures. The release’s specificity and its reliance on requirements that have themselves previously been cited in suits pertaining to more traditional environmental disclosures raise the question whether suits pertaining to climate change-related disclosure may be next.

 

The release cites several existing disclosure rules that it says required public companies to provide disclosures regarding climate change, including Items 101, 103 and 303 (among others) in Regulation S-K.

 

The release also identifies four topics that could require climate change-related disclosures, including: the impact of climate change legislation and regulation; the impact of international climate change accords; indirect consequences of climate change regulation or business trends; and the physical impacts of climate change.

 

Public companies will now have to accommodate their disclosure practices to the SEC’s guidance. While the SEC claimed only to be clarifying existing requirements, the practical reality is that many companies will now have to reconsider their disclosure process and practices, and, in many cases, alter the content of their disclosures.

 

With the SEC’s clarification of the disclosure requirements comes the opportunity for claimants or even for the SEC itself to later allege that a company’s climate change disclosures fell short of requirements. By way of illustration of how these claims might arise, it is worth considering that the very disclosure provisions with respect to which the SEC provided its climate change guidance have previously served as reference points in claims alleging misrepresentations or omissions of more traditional environmental liabilities and exposures.

 

For example, as I noted in a prior post (here), the SEC has in the recent past brought disclosure-related enforcement actions against reporting companies for alleged failures to observe existing environmental reporting requirements.

 

Nor are these types of claims limited solely to regulatory enforcement actions; investors have also brought damages actions relating to alleged misrepresentations or omissions regarding environmental issues. For example, as I noted in a recent post here, shareholders of Tronox Corporations recently filed a securities class action lawsuit against the company and certain of its directors and offices, as well as the company’s corporate predecessors in interest, based upon the company’s alleged failure to disclose the true nature of its environmental and tort liabilities.

 

There may be a temptation to view climate change related considerations as remote and distant future concerns, but as I noted in a recent post here, climate change related issues are already a practical component of current business conduct, for example, in the M&A context.

 

Just as disclosure obligations regarding traditional environmental concerns have given rise to disclosure-related enforcement actions and even shareholder litigation, the newly clarified expectations regarding climate change disclosures seem likely to create a context out of which similar actions may arise in the future.